Building on Kyoto: Towards a Realistic Global Climate Change Agreement and What Australia Should Do Warwick J. McKibbin & Peter J. Wilcoxen ANU Public Lecture, 3 July 2008
Overview Climate Science Lessons from Kyoto Why uncertainty matters An approach that focuses on uncertainty Some illustrations Accelerated deployment of advanced technology Conclusion for the Australian policy debate 2
Climate Science Significant body of opinion by scientists that we need to reduce greenhouse concentrations in the atmosphere to reduce the risk of dangerous climate change. 3
Climate Science Science does not tell us what the global concentration target should be - but it guides us Science does not tell us which of the many global paths of emissions should be followed for a given concentration target Science has nothing to say about what target an individual country should follow 4
Climate Change Policy Should be about enabling the whole society to manage the risks associated with climate change Should be about creating long term institutions and clear policy frameworks that can steer the global economy towards a less carbon intensive future Should be about creating a system that all countries find in their own self interest to be involved 5
Lessons from Kyoto Experience A system of rigid targets and timetables is difficult to negotiate because it is a zero sum game It is problematic for countries to commit to a rigid target for emissions under uncertainty about costs Even the most dedicated countries may be unable to meet their targets due to unforeseen events out of their control 6
Key Point Different global climate policy regimes handle uncertainty very differently National climate policy needs to deal with uncertainty as well 7
Some Examples Use a global economic model to show some key uncertainties and how to deal with these issues in the global framework Policy design should not rely on even the best economic models to be correct 8
Countries (10) The G-Cubed Model United States Japan Australia Europe Rest of OECD China India Eastern Europe and Former Soviet Union Oil Exporting Developing Countries Other non Oil Exporting Developing Countries Solved annually
The G-Cubed Model Sectors (12) Electric Utilities Gas Utilities Petroleum Refining Coal Mining Crude Oil and Gas Extraction Other Mining Agriculture, Fishing and Hunting Forestry and Wood Products Durable Manufacturing Non Durable Manufacturing Transportation Services Capital Producing sector
An illustrative example Generate a baseline of the model from 2002 to 2150 Create a target path for emissions reduction to reach a global target of peaking emissions by 2028 and to be 60% below 2002 emissions by 2100. Impose an arbitrary but approximately equal burden across countries 11
An illustrative example Implement the policy by Country specific target Permit trading globally 12
1000 800 600 400 200 0 Australia CO2 Emissions from Energy 2016 2020 2024 2028 2032 2036 2040 2044 2048 2008 2012 BAU Target
25000 20000 15000 10000 5000 0 China CO2 Emissions from Energy 2016 2020 2024 2028 2032 2036 2040 2044 2048 2008 2012 BAU Target
18000 16000 14000 12000 10000 8000 6000 4000 2000 0-2000 Figure 2: Carbon Prices by Country USA JPN AUS EUR OEC CHI IND EEB 2050 2040 2042 2044 2046 2048 2020 2022 2024 2026 2028 2030 2032 2034 2036 2038 2018 2016 2014 2012 2010 2008 cents per ton C
Now Allow Carbon Trading Suppose initial allocation of permits is BAU emissions for illustrative purposes only Generates a common world price High cost abaters will buy permits Low cost abaters will sell permits 16
1000 800 600 400 200 0 Australia CO2 Emissions from Energy 2016 2020 2024 2028 2032 2036 2040 2044 2048 2008 2012 BAU Target Trading
12000 10000 8000 6000 4000 2000 0 USA CO2 Emissions from Energy 2012 2016 2020 2024 2028 2032 2036 2040 2044 2048 BAU Target Trading 2008
Australia GDP Change 0-12008 2013 2018 2023 2028 2033 2038 2043 2048-2 -3-4 -5-6 -7-8 Target Trading
Trading is good in theory Permit trading across countries reduces aggregate economic costs but does not solve the problem of uncertainty about the future costs of emissions control Political problem of transferring wealth offshore to pay for abatement Problem with short term price volatility and market manipulation 20
The Importance of permit allocation Now instead of BAU emissions suppose allocation is based on per capita emission rights 21
Table 2: Allocation of CO2 Permits BAU Per Capita BAU Per Capita 2013 2013 2040 2040 USA 6695 1502 6169 1484 Japan 1398 588 1286 414 Australia 415 103 385 104 Europe 4150 1713 3816 1429 Other OECD 666 296 618 278 China 8375 6321 9099 5197 India 1733 5852 1945 6045 non oil LDCS 5139 12875 5930 14792 EEFSU 2860 1075 2726 758 OPEC 1690 2797 1587 3061 Total 33121 33121 33562 33562 Source: Model simulations and UN Population Medium Term Projections
Australia GNP Change 0-12008 2013 2018 2023 2028 2033 2038 2043 2048 % deviation -2-3 -4-5 -6-7 Target Trading Trading per capita
India GNP Change 2 0 2008 2012 2016 2020 2024 2028 2032 2036 2040 2044 2048-2 -4-6 -8 Target Trading Trading per capita % deviation
Uncertainty on the allocation Creates large differences in cost across countries exacerbated by trading. Countries don t know the costs of compliance before committing to the policy This is extremely difficult to negotiate without having a clear mechanism for non compliance 25
What is needed Need to negotiate a global target that can be adjusted over time as information on climate and costs of compliance change Need to negotiate an initial goal for each country but have a clear method for fairly dealing with non compliance due to unexpected excessive costs over time 26
An alternative Hybrid approach: The McKibbin Wilcoxen Hybrid Aim Impose a long term carbon goal for the world and distribute across economies Generate a long term price for carbon in each country to guide energy related investment decisions Line up short term economic costs across countries with expected environmental benefits Provide a way for corporation and households to manage climate risk Each country adopts nationally and cooperate globally 27
Components of the Policy Long-term permits A bundle of annual permits with different dates that the permits can be used Quantity of permits over time is the long run goal Supply is fixed (and diminishing) and allocated to households and industry Traded in a market with a flexible price 28
Components of the Policy Annual permits Must be acquitted against carbon emissions in the year of issue Expire in year of issue Elastic supply from national government Price fixed for five (or ten) years and then reset given information available Act as a safety valve to cap short term costs Company must have a permit to emit carbon 29
2010 2011 2012 2013 2014 2015 2016 2017 2018 Text Text 2019 Text Text Text Text Text Text Text Text Text
National Permit Markets coordinated through International Cooperation Independent but coordinated via P T US Japan P T EU Australia 31
Fig 2: Emissions and Long Term Permits 120 100 Emission/allocations 80 60 40 20 0 2000 2010 2020 2030 2040 2050 2060 2070 2080 2090 2100 long term permits actual emissions safety valve price reset 32
2099 2104 160 140 120 100 80 60 40 20 0 Figure 3 : Annual Permit Price 33 2089 2094 2084 2024 2029 2034 2039 2044 2049 2054 2059 2064 2069 2074 2079 2014 2019 2006 $US 2002
Figure 4 : Stylized Value of Long Term Permits (Assuming r=5%) 3000 2500 2000 1500 1000 500 0 34 2006 2015 2021 2027 2033 2039 2045 2051 2057 2063 2069 2075 2081 2087 2093 2099 2105 $US 2002
Impact of Uncertainty in shocks Suppose developing countries (China, India, LDCs) have 3% per year higher productivity growth from 2003 to 2020 35
1.6 1.4 1.2 1 0.8 0.6 0.4 0.2 0 Japan GDP Change 2016 2020 2024 2028 2032 2036 2040 2044 2048 Global cap & trade Hybrid 2012 2008 % deviation from BAU
1 0.8 0.6 0.4 0.2 0-0.2-0.4 Australia GDP Change 2016 2020 2024 2028 2032 2036 2040 2044 2048 Global cap and trade Hybrid 2012 2008 % deviation from BAU
Impact of Uncertainty Far greater problem under a rigid cap and trade system Could be sufficient to prevent any effective international agreement Uncertainty even greater for developing countries A hybrid approach enables countries to negotiate targets knowing the maximum costs to be incurred and the rules for adjustment over time 38
Accelerated Deployment of Advanced Technology BAU results assume technology evolves at historical rates What if this could be accelerated? Modeled as fossil fuel augmenting technical change (reduce the fuel mix in electricity generation away from fossil fuels). 39
12000 10000 8000 6000 4000 2000 0 USA CO2 Emissions from Energy 2012 2016 2020 2024 2028 2032 2036 2040 2044 2048 BAU High Innovation 2008
25000 20000 15000 10000 5000 0 China CO2 Emissions from Energy 2016 2020 2024 2028 2032 2036 2040 2044 2048 2008 2012 BAU High Innovation
Conclusions for the Global Debate Conventional targets and timetables approach without flexibility does not deal with uncertainty (particularly for developing countries) Forces focus on dividing up a rigidly fixed pie Need a policy of agreed actions through national frameworks coordinated through a common carbon price in each system The international framework needs to balance the global target with the relative economic costs across countries of achieving that target 42
Conclusions for Policy Need to encourage research and development in advanced technology in energy generation and energy use alongside the international climate framework Advanced technology likely to be more quickly deployed under the incentives created by the Hybrid approach Need to build in deforestation urgently 43
What Australia Should Do A conventional cap and trade system is not adequate for Australia Excessive short term price volatility Cannot control the short term costs while evolving into a global system Does not provide the capacity to manage long term climate risk Revenue should be in the hands of the innovators and the population and not the governments, especially not the state governments Does not fit with the actual policies being explored in the post Kyoto world. 44
Key Message Australia should be at the forefront of the design of a global system that includes the major emitters but based on comparative advantage not arbitrary targets and cap and trade systems Most of the cost to Australia of a carbon target for the world comes from what other countries do not what is done in Australia 45
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